The Valuation of Corporate Fixed Income Securities
We develop contingent claims valuation models for corporate bonds that are capable of generating yield spreads consistent with the levels observed in practice. We incorporate important features in the valuation related to the occurrence of and payoff upon bankruptcy and focus on the default risk of coupons in the presence of dividends and interest rate uncertainty. Numerical solutions are employed to show that the resulting yield spreads are sensitive to interest rate expectations but not to the volatility of the interest rates. Interaction between call provisions and default risk in determining yield spreads is explicitly analyzed to show that the call provision has a differential effect on Treasury issues relative to corporate issues.
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